I vividly remember in my first job in 2007, a colleague running to the nearest Northern Rock branch and queuing up in what was literally a bank run. There were no queues outside of Silicon Valley Bank, Signature Bank or Credit Suisse in this increasingly digital age, but as we now all know, the outcome was the same. In the complicated world of financial plumbing, it is often very hard to spot the leak before it is too late. And it still confounds us that so-called “experts” come out post these events model – after the horse has bolted and fled into the next village – to talk about the offending financial products that created the loss of confidence, as if they knew all along that these were obvious risks in the business.

As with other sectors investors can make money investing in banks, but we believe the risks usually outweigh the potential returns.
Leap of faith
Banks are complicated business models to understand and analyse. They are vast structures where complex financial instruments are created and traded every single day. Risk management is hugely important and having a clear oversight of where the dangers lie is key for an executive management to be effective. But therein lies an issue with investing in banks – it can be very difficult for investors to have a full understanding of the risks that lie beneath the various bank portfolios. A small hole can give rise to a sinking ship and by the time you as an investor know about it, it can be far too late. A functioning banking system requires confidence, and should the market get a whiff that the foundations are cracking, not all investors and depositors can fit through the exit door. In our view, investing in banks requires forensic attention, a leap of faith on the “unknown unknowns” and a good dose of luck.

However, our main reason for avoiding the sector in our portfolios today is down to the commoditisation of the industry and lack of long-term pricing power. How many bank cards do you have in your wallet (physically or virtually) right now? In the UK for example, competitive behaviour is probably turning your local bank branch into a pet grooming salon or a coffee shop as digital-only banks take share from the household names that have legacy infrastructure.
Lowest price wins
Is there really a difference between mortgage A and mortgage B other than price? Bank customers tend to gravitate to those products that cost the least – this means that higher returns seen at the beginning of an interest rate cycle are likely to be quickly arbitraged away. In previous decades pricing transparency was relatively low while customer stickiness was relatively high. The digital age has materially improved price transparency and reduced the strength of customer relations, resulting in an even tougher margin environment. To compensate, some banks choose to create more complex products, offer more aggressive lending or lower risk thresholds, which in turn raises the probability of a leak occurring under the water line.

While technological leadership could also give a bank material cost advantages and better user experiences — resulting in higher returns — we see the sector as a whole as a long-term, low-return industry full of competitive threats and rising regulations.
Better opportunities
These factors lead us to believe that there are more attractive opportunities outside of large banking institutions. At the core of our investment process, we look for businesses with competitive advantages and pricing power. This can come from network advantages, innovative products or brand strength. Within financials we believe that there are some opportunities to find these; for example Nexi, the Italian digital payment provider. The company has a network advantage as the market leader in Italy, which allows this business to leverage its cost base. Italian digital payment penetration continues to grow, taking share from cash payments. This move away from cash also benefits tax take and so has government support. With control of the market, Nexi has an element of pricing power in the rate it charges merchants to use the platform. Valuation and long-term market opportunity here remain attractive.

In conclusion, we want to focus on companies that can provide attractive returns above the cost of capital over the long term. It is true that at times of the economic cycle being underweight banks can hurt performance of a fund or portfolio. Over the long run, however, we are quite convinced that the competitive pressures, increasing regulation and pricing transparency will result in an industry where returns are likely to revert to the cost of capital or below.

Please note: Stock examples are for illustrative purposes only and are not a recommendation to buy or sell.

The value of active minds: independent thinking


A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

Important Information

This document is intended for investment professionals and is not for the use or benefit of other persons. This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. Issued in the UK by Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ is authorised and regulated by the Financial Conduct Authority. Issued in the EU by Jupiter Asset Management International S.A. (JAMI), registered address: 5, Rue Heienhaff, Senningerberg L-1736, Luxembourg which is authorised and regulated by the Commission de Surveillance du Secteur Financier. No part of this document may be reproduced in any manner without the prior permission of JAM/JAMI. 390